Question
Explain the meaning of income effect and substitution effect.
| Points | Income Effects | Substitute Effects |
| Meaning | The monetary income of consumer is constant if price of commodity decreases, the real income of the consumer increase and his purchasing power increases. Thus, the resulting demand is called income effect. On the contrary, if the price of the commodity goes up, the real income of the consumer decreases purchasing power deceases and as a result demand decreases. | When the price of a commodity decrease it becomes cheaper than its substitute. The consumer decreases his purchase of substitutes and increases his demand of the original commodity. On the other hand, if price of commodity goes up, it become dearer than its substitutes. Thus, its demand decrease. This is called substitute effect. |
| Example | A consumer spends $50$ on sugar when the price of sugar is $Rs.10,$ he is able to buy $5\ k.g.$ sugar. Now the price goes down to Rs.8. Now he has to spend $40$ for $5\ k.g.$ of sugar. Now, he can buy more | If all other cold drinks remain unchanged in price and the price of Pepsi decreases, the demand of Pepsi sugar with $10$ spent by him. This is income effect. |
| Effects | Sugar with $10$ spent by him. This is income effect. Income effect can be positive or negative. | This effect is always positive. |
Generate a complete, print-ready paper with questions like this in minutes — across 16+ boards, with answer keys.